After fiscal cliff comes fiscal chasm

John Nyaradi is Publisher of
Wall Street Sector Selector, a financial media site focused on news,
analysis and information about exchange traded funds and global financial and
economic developments.
John's investment articles have appeared in many online publications including
MarketWatch, Trading Markets, Money Show, Yahoo Finance, Investors Insight,
Fidelity, ETF Daily News, iStock Analyst and his interviews have appeared on
MarketWatch, Yahoo Finance's Breakout, National Business Talk Radio, Sound
Investing, and The Index Investing Show. His book, "Super
Sectors: How to Outsmart the Market Using Sector Rotation and ETFs", is
included among the Years Top Investment Books in the 2011 Stock Trader’s
Almanac.

Whether or not the dreaded fiscal cliff is resolved by New Year's Eve, a second, bigger problem awaits in 2013: The Fiscal Chasm

We have been hearing plenty about the fiscal cliff these days — including what will happen if we go over it. One subject we aren't hearing discussed is what will happen even if we avoid the cliff. After all, avoiding the cliff will involve some costs: some taxes will be increased and some government spending will be cut. We have been led to believe that the tax increases will only be imposed on billionaires who would never notice the difference anyway. As for the spending cuts, we are supposed to believe that only wasteful programs will be affected.

Economist Nouriel Roubini speaks as though it won't matter whether we avoid the cliff or not. "Dr. Doom's" opinion is that we will briefly go over the cliff, and the market reaction will then force the two sides to reach an agreement. Nevertheless, after the cliff is passed, 2013 will bring "barely 1.7%" GDP growth because the "headwinds" caused by the new taxes and fiscal policy will reduce GDP by approximately 1.4%.

Beyond that significant headwind, we also have to consider the impact of the European situation on the U.S. economy. Europe is already in recession, and we rely on Europe as our biggest trading partner to buy American-made products. Dr. Roubini has repeatedly described the euro zone as a "slow-motion train wreck." The question of whether the European economic crisis will impact the American economy does not appear as important as the question concerning how significantly the European situation will cause trouble for us.

Plenty of problems await the United States' economy once it gets past the cliff. In fact, there are so many that what awaits us is a fiscal chasm — a Grand Canyon carved out of our economy by the expenses of the future rather than a glacier from the past.

At some point, the federal government will be forced to address the dilapidated national infrastructure which has not been maintained for decades. The individual states will have to face their own infrastructure problems, while both the federal and state governments will be drawing on an emaciated tax base due to forecast ongoing high unemployment.

As we heard many times during the health-care debate, the American health-care delivery system is absurdly overpriced and inefficient. The current system imposes administrative expenses which are 30% higher than the cost of actually keeping people healthy. As baby boomers age and require more medical treatment, someone is going to have to pay those bills, and many of the patients won't have enough money to pay their share — even assuming that health-care bill’s modest benefit plan is in place. Ultimately, the taxpayers will foot the bill.

An even darker picture has been painted by the Congressional Budget Office, which estimates that payments for Social Security, Medicaid, Medicare and payment on the debt could absorb 100% of federal revenue by 2025 without changes to things like the Bush tax cuts and current Medicare payment levels. The National Commission on Fiscal Responsibility and Reform came to a similar conclusion, as did the General Accounting Office, which places the time frame for revenue exhaustion sometime between 2020 and 2030.

So as the fiscal-cliff debate unfolds, investors must already start looking to and planning for the next headline event, the fiscal chasm, which will turn out to be a rocky road over the next 20 years and will make today's fiscal cliff seem like Happy Days. As we approach 2013, Wall Street Sector Selector remains in "red flag" mode, seeing more danger than opportunity in the days and months just ahead.

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